Market Update: BI Needs Further Rate Hike to Stabilize Rupiah

Economy and Monetary Director of BI Yoga Affandi - Photo by TheInsiderStories

JAKARTA (TheInsiderStories)Bank Indonesia (BI) should to raise its benchmark rate again in order to stabilize the rupiah. This month, the Bank raised its key interest rate by 25 basis point (bps) to 4.50 per cent for the first time since 2014 to support the rupiah and stabilize domestic markets.

The central bank also raised its deposit facility rate by 25 basis points to 3.75 percent, and its lending facility rate by 25 basis points to 5.25 percent. It is been four days after Bank Indonesia raised its benchmark rate, but rupiah has not shown any signs of strengthening.

Rupiah continued to weaken against U.S Dollar to Rp14,200 at 14.38 p.m. According to the Jakarta Interbank Spot Dollar Rate (JISDOR), rupiah weakened to Rp14,176 on May 21, 2018, down 0.48 per cent from May 18, 2018. This level is the weakest since October 2015.

The rupiah weakening comes as foreign capital shift their portfolio to U.S treasuries. The 10-year U.S Treasuries return reaches above 3 per cent since last week. The U.S dollar index was recorded at its highest level since November 2017.

Since the beginning of the year to date, foreign investors have been selling of Rp40,98 trillion (US$2.91 billion) in domestic stocks. In addition, the expectation of a Federal Fund Rate increase also affects investors. The Fed is expected to raise the rate three times this year as initially planned.

But analysts predict that a fourth increase looms as inflation is rising. Markets have been watching for clues on the pace of the world’s most influential central bank will take its monetary tightening trajectory this year.

Investors want to ensure whether the Fed will take an aggressive rate hike or still in line with expectations. While waiting, investors seem to have started taking positions by collecting U.S dollars. As a result, most other currencies including rupiah are weakening.

Furthermore, investors riddled with concerns over Indonesia’s current account deficit as it reflects foreign reserve from trade. Foreign reserve from the trade is more sustainable to support exchange rate rather than capital flows in the capital market.

Indonesia recorded current account deficit of $5.5 billion, or 2.15 per cent of GDP, in the first three months this year. It potentially widens as Indonesia posted a surprise US$1.63 billion trade deficit in April 2018, the largest since $1.96 billion in April 2014.

To stabilize the rupiah amid onslaught from internal and external factors, Bank Indonesia needs to further raise its key interest rate to strengthen rupiah. The previous interest rate rise of 25 basis points shows no effect on the rupiah.

The rise in interest rate is unpopular as it could hurt the people’s purchasing power. It also brings negative effect to the financial market. But the increase in interest rate is urgently needed if the rupiah continues to weaken. BI could increase 25 basis points in the first semester of this year to maintain rupiah.

In the last governor meeting on May 17, 2018, Bank Indonesia Governor Agus Martowardojo, whose term as governor will end later this month, also hinted that BI stands ready to take more firm actions in order to stabilise the financial system and the economy.

US$1: Rp14,100